Voices
Echoes of the Black Monday Crash of '87

(Bloomberg View) — During periods of confusion — that is, almost all of the time — investors often look to the historical record for insight. They want to understand the present by gazing into the past, even when the analogy doesn't quite work.

We all read about issues such as peak earnings, New York Stock Exchange, margin debt, sentiment, volatility, national deficits, even rising home prices, and try to draw comparisons with yesteryear.

Perhaps my favorite of these exercises are the false parallels that have been drawn repeatedly between today and the 1987 crash.

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Most of the underlying factors that drove that meltdown were very different from today's market structure. First and foremost among those differences is portfolio insurance. This was a product so foolish it is hard to imagine today. How could anyone think buying puts — which become more valuable as the price of the underlying stock falls — amid a downturn would protect against further losses?

I guess the idea was that option traders were going to become insurance underwriters for portfolio managers and absorb all of the losses. Add to that the creaky NYSE infrastructure, during a pre-computerized, manual trading era when transactions were made face-to-face or over the phone. If you can imagine what happened when traders stopped answering the phones to avoid taking another "sell" order, well, add all that together and most of the mystery of the 1987 crash is solved.

However, there are a few parallels that I do think are worth mentioning. To my eye, I find the following attributes of 1987 most intriguing:

The rally from 1982-87 followed a 16-year bear market where stocks were extremely volatile, with big rallies and selloffs. In that period before the bull market started, stocks were essentially unchanged — and that's before accounting for a lot of inflation in the 1970s and early 1980s.

A Federal Reserve chief turned out to be particularly friendly to equity markets, and was willing to keep lowering interest rates.

A bull market had begun in 1982, when stock indexes broke out to new highs for the first time in more than a decade.

The move off of the 1982 break out was greeted with broad skepticism and disbelief by investors. Even five years later, there was still plenty of doubt.

Despite this doubt, during the next five-plus years, the S&P 500 would almost triple in value.

The relevant parallels end there. The start of 1987 saw a hot market running way ahead of itself. The Dow gained almost 14% during January 1987 alone; as summer was ending, the index was up almost 44% by Aug. 25, while the S&P 500 was up more than 39%. From there, markets started to lose ground, falling almost 15% from the peak through Oct. 15. On the Friday before the crash, the Dow fell 4.6%.

Then the crash, an epic plunge that still holds top ranking in the record books.

Even though many of the parallels that pundits are trying to draw between now and then are a stretch, there are still worthwhile lessons to learn from accounts of that episode. I highly recommend Tim Metz's seminal book on the topic, "Black Monday: The Catastrophe of October 19, 1987." Diana B. Henriques's "A First-Class Catastrophe: The Road to Black Monday, the Worst Day in Wall Street History" is in my reading queue, but I have yet to start it.

George Santayana's great maxim was that those who do not learn from history are doomed to repeat it. Perhaps there should be a corollary about learning the wrong lessons from history as well.